Non-GAAP measures
Certain discussions and analyses set out in this Annual Report and Accounts include measures which are not defined by generally accepted accounting principles (GAAP) such as IFRS. We believe this information, along with comparable GAAP measurements, is useful to investors because it provides a basis for measuring our operating performance, ability to retire debt and invest in new business opportunities. Our management uses these financial measures, along with the most directly comparable GAAP financial measures, in evaluating our operating performance and value creation. Non-GAAP financial measures should not be considered in isolation from, or as a substitute for, financial information presented in compliance with GAAP. Non-GAAP financial measures as reported by us may not be comparable to similarly titled amounts reported by other companies.
In the following sections we set out our definitions of the following non-GAAP measures and provide reconciliations to relevant GAAP measures:
- Ungeared free cash flow;
- Return on invested capital;
- Underlying sales growth; and
- Net debt.
We set out 'Measures of long-term value creation' as an introduction to the following section, in order to explain the relevance of the above measures. At the end of this section we summarise the impact on Total Shareholder Return (TSR) which is a key metric.
Measures of long-term value creation
Unilever's ambition for the creation of value for shareholders is measured by Total Shareholder Return over a rolling three-year period compared with a peer group of 20 other international consumer goods companies.
Unilever believes that the contribution of the business to this objective can best be measured and communicated to investors through the following measures:
- The delivery, over time, of Ungeared Free Cash Flow (UFCF), which expresses the translation of profit into cash, and thus longer-term economic value; and
- The development, over time, of Return on Invested Capital (ROIC), which expresses the returns generated on capital invested in the Group.
Unilever communicates progress against these measures annually, and management remuneration is aligned with these objectives. The UFCF over a three-year period is incorporated as a performance element of Unilever's management incentive scheme.
UFCF and ROIC are non-GAAP measures. We comment on these in detail here since they are the way in which we communicate our ambition and monitor progress towards our longer-term value creation goals and in order to:
- improve transparency for investors;
- assist investors in their assessment of the long-term value of Unilever;
- ensure that the measures are fully understood in the light of how Unilever reviews long-term value creation for shareholders;
- properly define the metrics used and confirm their calculation;
- share the metrics with all investors at the same time; and
- disclose UFCF as it is one of the drivers of management remuneration and therefore management behaviour.
As investor measures, we believe that there are no GAAP measures directly comparable with UFCF and ROIC. However, in the tables set out below under Ungeared free cash flow and Return on invested capital, we reconcile each as follows: UFCF to cash flow from operating activities and also to net profit; ROIC to net profit.
Caution
Unilever cautions that, while UFCF and ROIC are widely used as tools for investment analysis, they are not defined terms under IFRS and therefore their definitions should be carefully reviewed and understood by investors. Investors should be aware that their application may vary in practice and therefore these measures may not be fully comparable between companies. In particular:
- We recognise that the usefulness of UFCF and ROIC as indicators of investment value is limited, as such measures are based on historical information;
- UFCF and ROIC measures are not intended to be a substitute for, or superior to, GAAP measures in the financial statements;
- The fact that ROIC is a ratio inherently limits its use, and management uses ROIC only for the purposes discussed above. The relevance and use of net profit for the year (being the most relevant comparable GAAP measure) is clearly more pervasive; and
- UFCF is not the residual cash available to pay dividends but represents cash generated by the business and broadly available to the providers of finance, both debt and equity.
Ungeared free cash flow (UFCF)
UFCF expresses the generation of profit by the business and how this is translated into cash, and thus economic value. It is therefore not used as a liquidity measure within Unilever. The movement in UFCF is used by Unilever to measure progress against our longer-term value creation goals as outlined to investors.
UFCF is cash flow from group operating activities, less net capital expenditure, less charges to operating profit for share-based compensation and pensions, and less tax (adjusted to reflect an ungeared position and, in 2006, for the impact on profit on sales of frozen foods businesses), but before the financing of pensions.
In 2007, UFCF was €3.8 billion (2006: €4.2 billion; 2005: €4.0 billion). The reconciliation of UFCF to the GAAP measures net profit and cash flow from operating activities is shown below.
The tax charge used in determining UFCF can be either the income statement tax charge or the actual cash taxes paid. Our consistently applied definition uses the income statement tax charge in order to eliminate the impact of volatility due to the variable timing of payments around the year end. For 2006 the income statement tax charge on this basis was materially impacted by the tax effect of non-cash charges for the provision for preference shares and certain other non-cash items. UFCF for 2007 based on actual cash tax paid would have been €3.6 billion (2006: €4.5 billion; 2005: €3.7 billion).
Ungeared free cash flow |
€ million 2007 |
€ million 2006 |
€ million 2005 |
|---|---|---|---|
| Net profit | 4 136 | 5 015 | 3 975 |
| Taxation | 1 137 | 1 332 | 1 301 |
| Share of net profit of joint ventures/associates and other income from non-current investments | (191) | (144) | (55) |
| Net finance costs | 252 | 725 | 618 |
| Depreciation, amortisation and impairment | 943 | 982 | 1 274 |
| Changes in working capital | 27 | 87 | 193 |
| Pensions charges in operating profit less payments | (910) | (1 038) | (532) |
| Movements in provisions less payments | 145 | 107 | (230) |
| Elimination of profits on disposals | (459) | (1 620) | (789) |
| Non-cash charge for share-based compensation | 118 | 120 | 192 |
| Other adjustments | (10) | 8 | (23) |
| Cash flow from operating activities | 5 188 | 5 574 | 5 924 |
| Less charge for share-based compensation | (118) | (120) | (192) |
| Add back pension payments less pension charges in operating profit | 910 | 1 038 | 532 |
| Less net capital expenditure | (983) | (934) | (813) |
| Less tax charge adjusted to reflect an ungeared position | (1 228) | (1 336) | (1 440) |
| Taxation on profit | (1 137) | (1 332) | (1 301) |
| Taxation on profit on sales of frozen foods businesses | – | 159 | – |
| Tax relief on net finance costs | (91) | (163) | (139) |
| Ungeared free cash flow | 3 769 | 4 222 | 4 011 |
Return on invested capital (ROIC)
ROIC expresses the returns generated on capital invested in the Group. The progression of ROIC is used by Unilever to measure progress against our longer-term value creation goals outlined to investors.
ROIC is profit after tax but excluding net interest on net debt and impairment of goodwill and indefinite-lived intangible assets both net of tax, divided by average invested capital for the year. Invested capital is the sum of property, plant and equipment and other non-current investments, software and finite-lived intangible assets, working capital, goodwill and indefinite-lived intangible assets at gross book value and cumulative goodwill written off directly to reserves under an earlier accounting policy.
In 2007, ROIC was 12.7% (2006: 14.6%). The reconciliation of ROIC to the GAAP measure net profit is shown below.
There were no disposals of discontinued operations in 2007; the impact of such disposals in 2006 and 2005 was €1.2 billion and €0.5 billion respectively. ROIC is based on total business profit, including profit on such disposals. ROIC excluding this impact in 2007 is 12.7% (2006: 11.5%; 2005: 11.3%).
| Return on invested capital | € million 2007 |
€ million 2006 |
€ million 2005 |
|---|---|---|---|
| Net profit | 4 136 | 5 015 | 3 975 |
| Add back net interest expense net of tax | 314 | 365 | 424 |
| Add back impairment charges net of tax(a) | 1 | 15 | 245 |
| Profit after tax, before interest and impairment of goodwill and indefinite-lived intangible assets | 4 451 | 5 395 | 4 644 |
| Year-end positions for invested capital: | |||
| Property, plant and equipment and other non-current investments | 7 276 | 7 142 | 7 333 |
| Software and finite-lived intangible assets | 590 | 608 | 642 |
| Inventories | 3 894 | 3 796 | 4 107 |
| Trade and other receivables | 4 965 | 4 667 | 5 185 |
| Trade payables and other creditors due within one year | (8 545) | (8 513) | (8 782) |
| Elements of invested capital included in assets and liabilities held for sale | 150 | 15 | 200 |
| Goodwill and indefinite-lived intangible assets at gross book value | 20 029 | 20 705 | 21 621 |
| Total | 28 359 | 28 420 | 30 306 |
| Add back cumulative goodwill written off directly to reserves | 6 427 | 6 427 | 6 870 |
| Year-end invested capital | 34 786 | 34 847 | 37 176 |
| Average invested capital for the year | 35 122 | 36 850 | 37 012 |
| Return on average invested capital | 12.7% | 14.6% | 12.5% |
| Return on average invested capital excluding profit on disposal of discontinued operations | 12.7% | 11.5% | 11.3% |
(a) Excluding write-downs of goodwill and indefinite-lived intangible assets taken in connection with business disposals.
Underlying sales growth (USG)
USG reflects the change in revenue from continuing operations at constant rates of exchange, excluding the effects of acquisitions and disposals. It is a measure that provides valuable additional information on the underlying performance of the business. In particular, it presents the organic growth of our business year on year and is used internally as a core measure of sales performance.
The reconciliation of USG to changes in the GAAP measure turnover is as follows:
| 2007 vs 2006 |
2006 vs 2005 |
|
|---|---|---|
| Underlying sales growth (%) | 5.5 | 3.8 |
| Effect of acquisitions (%) | 0.1 | 0.1 |
| Effect of disposals (%) | (0.9) | (0.8) |
| Effect of exchange rates (%) | (3.1) | 0.3 |
| Turnover growth (%) | 1.4 | 3.2 |
Net debt
Net debt is defined as the excess of total financial liabilities, excluding trade and other payables, over cash, cash equivalents and financial assets, excluding amounts held for sale. It is a measure that provides valuable additional information on the summary presentation of the Group's net financial liabilities and is a measure in common use elsewhere. The net debt definition in our 2007 reporting has not changed in substance from previous years, however, the terminology has been updated to correspond with that appearing on the balance sheet.
The reconciliation of net debt to the GAAP measure total financial liabilities is as follows:
| € million 2007 |
€ million 2006 |
|
|---|---|---|
| Total financial liabilities | (9 649) | (8 835) |
| Financial liabilities due within one year | (4 166) | (4 458) |
| Financial liabilities due after one year | (5 483) | (4 377) |
| Cash and cash equivalents as per balance sheet | 1 098 | 1 039 |
| Cash and cash equivalents as per cash flow statement | 901 | 710 |
| Add bank overdrafts deducted therein | 197 | 329 |
| Financial assets | 216 | 273 |
| Net debt | (8 335) | (7 523) |
Total Shareholder Return (TSR)
TSR measures the returns received by a shareholder, capturing both the increase in share price and the value of dividend income (assuming dividends are re-invested). Unilever's TSR performance is compared with a peer group of competitors over a three-year rolling performance period. This period is sensitive enough to reflect changes but long enough to smooth out short-term volatility. The return is expressed in US dollars, based on the equivalent US dollar share price for NV and PLC. US dollars were chosen to facilitate comparison with companies in Unilever's chosen reference group. The choice of currency affects the absolute TSR but not the relative ranking.
Unilever's TSR target is to be in the top third of a reference group including 20 other international consumer goods companies on a three-year rolling basis. At the end of 2006 we were positioned 13th, and at the end of 2007 the ranking was 8th. In 2007, the following companies formed the peer group of comparative companies:
| Avon | Kraft | |
| Beiersdorf | Lion | |
| Cadbury Schweppes | L'Oréal | |
| Clorox | Nestlé | |
| Coca-Cola | Orkla | |
| Colgate | PepsiCo | |
| Danone | Procter & Gamble | |
| Heinz | Reckitt Benckiser | |
| Kao | Sara Lee | |
| Kimberly-Clark | Shiseido |
Unilever's position relative to the TSR reference group
The reference group, including Unilever, consists of 21 companies. Unilever's position is based on TSR over a three-year rolling period.
